Thank you, Chairman and members of the joint committee for inviting us here today to make a presentation to you.
We are delighted to appear before the committee today and to be given the opportunity not only to advise on the role played by IPSO and the payments industry in the Irish economy, but also, inter alia, to dispel a few myths and misconceptions about how payment systems in Ireland are organised and governed. I would like also to say a word or two about IPSO’s vision and strategic direction, what requires to be done and how I believe the committee could play a central role in helping the payments industry deliver on its objectives, which are of crucial national importance.
Finally, I wish to address a number of statements made about IPSO and access to payment systems at the hearing of the committee held on 11 July and subsequently reported in the media. I would welcome questions from members of the committee after my presentation, which I hope to wrap up in about 15 minutes.
What is the payments industry? Payment systems, such as those which support cheques, credit cards, debit cards, direct debits, high value transfers, etc., facilitate the exchange of value and the movement of the underlying payment instrument between payer and beneficiary in an economy. I shall give a few statistics to demonstrate the significance of payment systems in Ireland. For instance, 125 million cheques were cleared in Ireland last year, together with some 171 million retail electronic inter-bank transactions, that is, direct credits, such as salary payments, and direct debits.
The total annual transactions of Laser, Ireland's debit card, is of the order of 70 million transactions with a value of €4.2 billion. There are 1.2 million Laser cards on issue from a standing start seven years ago. IRIS, Ireland's high value inter-bank payment system, settles in real-time some €19 billion, in terms of value every day. Thus, payment systems are key economic infrastructures, critical to the smooth functioning of any economy.
If one of our payments systems were to fail, the impact could be to threaten the Irish economy. Robustness and reliability of payment systems and the standing and soundness of the full members in our payment systems are, therefore, of critical importance. These fundamental requirements underpin all our actions at IPSO.
Perhaps I can give members of the committee an example of a situation which occurred when I was in the UK. In 1997, the BACS system - the automated clearing house - failed and consequently some 50 million electronic retail payments did not take place. Wages and salaries were not paid, which without early and corrective action by the industry could have had a major consequential impact on customers. It is not just the failure of a bank that is at issue but operational failure of the system itself.
I am pleased to say that payment systems in Ireland have a robust risk control basis, operate to best practice principles, comply with international principles and standards issued by institutions such as the Bank for International Settlements, the European Central Bank and the OECD, and are regulated by the Central Bank - now the CBFSAI. We in the payments industry cannot be and we are not complacent.
What is IPSO? IPSO is the umbrella body for payment services for financial institutions in Ireland. The company provides strategic leadership and technical support to the payments industry in the non-competitive infrastructural arena, facilitates consultation among participants and represents the payments industry at national and international levels. It is a totally independent company and is not affiliated to any other company or organisation. IPSO provides strategic direction and leadership to the payments industry in a number of areas including technological developments, regulation, international developments and communicates strategic guidance to the various arms of the industry. Its other principal role is to promote the integrity, reliability, availability and soundness of payments systems on an ongoing basis, although the responsibility for this lies with the Central Bank as regulator of payment systems.
IPSO is keen to ensure the orderly and planned development of the Irish payments industry. Our key task is to drive the transition of end user customers to a modernised payments infrastructure which involves much greater use of electronic payments instead of cash and paper based payments in Ireland. By paper based payments we mean cheques. The Government has a key leadership role to play in this respect. I would like to return to this critical issue later in my presentation. It has significant relevance not only for Government costs but for Ireland's national competitiveness. In my opinion, this would be a very useful area of focus by your esteemed committee as a key catalyst in the parliamentary process.
IPSO and the clearing companies were set up in 1997 to meet public policy desires in Europe and globally to ensure that payment, clearing and settlement systems in all countries meet appropriate standards of safety, integrity and competitive openness. Contrary perhaps to popular belief, IPSO does not operate or control access to payment systems, nor does it have any power to set any payment systems rules or thresholds.
The payment systems in Ireland are operated by separate corporate entities, each having their own members and boards of directors. Payment systems in Ireland must be operated as limited companies which is a requirement of the Central Bank Act 1997.
The Central Bank and Financial Services Authority of Ireland is the regulator of payment systems in Ireland and must give its approval to all rules, including rules for membership and access to payment systems adopted by the clearing companies and to any changes to the rules. IPSO itself has gone through a significant transformation over the past two years, since I became chief executive. This has included a major governance review of IPSO with the appointment onto the board of two independent, non-executive directors who have no connection with the banking industry and the creation within IPSO of a new class of membership known as affiliate membership for non-banks. This process of change, which will be evolutionary, recognises a number of dynamic changes which are taking place in the payments systems environment.
There are four payment companies which are members of IPSO. The Irish Paper Clearing Company is responsible for the clearance of paper cheques and credit transfers; the Irish Retail Electronic Payments Clearing Company is responsible for the clearance of bulk low value electronic payments, such as direct debits and salary payments; the Irish Real-time Interbank Settlement system is responsible for high value electronic inter-bank payments and Laser is responsible for Ireland's debit card. Each company operates its own payments scheme and is wholly autonomous, responsible for its own decision taking, access criteria, operating rules, funding and development. Each member institution in a clearing company has a right to membership of IPSO and to representation on its board. It is not a mandatory requirement for a member of a clearing company to be a member of IPSO and several banks have chosen not to become members of it.
Laser has five full members and the IRIS has 20 full members, among them some of the biggest banks in the world. Currently, there are six full members of the IRECC and seven full members of the Irish Paper Clearing Company. I have listed the memberships in Appendix A to this presentation.
All the banks in the IRECC and the IPCC provide payment services to other credit institutions, which as a consequence become associate members of the relevant companies. For example, the latter bank on the list, BNP Paribas, acts as clearing agent for eight international banks, including Bank of America, Citibank and Bank of Scotland (Ireland).
The organisational and regulatory structure, therefore, allows institutions the freedom of choice to join the payment systems which best suit their business requirements. More importantly, banks and financial institutions can access Irish payment systems in order to provide competing banking services to customers without having to become full members or to incur the infrastructure and operational costs of full membership.
Each clearing company has publicly available access criteria which are fair, transparent and non-discriminatory. The rules have been applied consistently and no bank has ever been refused admission to any of the clearing companies. Two institutions, HSBC and the National Treasury Management Agency, joined the IRIS system as recently as 1999 and First Active rejoined the Laser scheme in July of this year. Following the creation of the IRECC and the IPCC there have been no new applications for full membership of these companies but 15 associated members - the mix of which includes small, medium and very large banks - have joined to avail of agency services.
The access criteria of all companies have been approved by the CBFSAI. The criteria are not complex. In broad terms, membership is open to any credit institution regulated by a Central Bank in the European Union or from a G10 country which has a settlement account at the Central Bank; meets the operational and technical requirements of the clearing company, this includes demonstrating its ability to honour its settlement commitments and its compliance with the rules for clearing; and submits a clearing plan, the purpose of which is to address the operational and technical matters referred to above and its projections as to likely volume transactions throughput - that is to show it would be a significant provider of money transmission services - to assist in capacity planning for the company and in the case of the paper clearing company to demonstrate achievement of the 1% minimum volume throughput requirement.
It should be noted that in 1995 the Competition Authority had no objection to the concept of 1% minimum volume threshold. The access criteria are broadly the same for all the clearing companies, although there are differences in certain of the criterion in different companies, reflecting the different nature of the specific operations. The access criteria are the same in substance as those which were reviewed by the Competition Authority and the Minister for Finance in 1995, even before the Central Bank was formally appointed as statutory regulator, and the criteria received a clean bill of health. We take particular cognisance of the observations in 1995 of the Minister for Finance when he said that "the thresholds applied for membership, the costs of membership and other provisions should not be prohibitive for institutions to participate". We in the IPSO and the clearing company boards entirely agree with these observations.
With regard to costs of participation, membership of the clearing companies involves the payment of costs by applicant institutions. The rules require that a new institution would pay an entry cost to cover an element of the past development costs of the clearing, including research, development, standards, training and administrative costs; pay to each of the incumbent members the impact costs which they incur in accommodating the new member into the clearing system - this may involve software changes, hardware changes, testing, stationary changes, resource impacts, etc.; and pay its fair and reasonable share of the ongoing operational costs of the company, which are determined by reference to actual costs incurred. The costs of the company are shared by members by reference to the respective volumes in the clearings.
Entry costs have been referred to also as sunk costs. Entry/sunk costs are generally acceptable from a competition law perspective as long as they are not objectively excessive. I refer to the Competition Authority's decisions in 1995 in that regard. The retail payment systems in Ireland operate primarily as own bank infrastructure and are operated by own bank clearing departments. No new entrant has to pay for this, rather a new entrant would need to invest in its own infrastructure and in its own personnel. Thus, to some extent, the concern expressed about buying into entry costs is misplaced as the system entry costs will be de minimis as opposed to own costs incurred.
It is only reasonable that a new entrant seeking to link up with existing clearing members should be required to pay for the costs incurred by them in accommodating the new entrant as long as the costs are not objectively excessive. This concept is adopted by payment systems throughout the world and thus avoids the free rider concept, with which the committee will be familiar.
It is also reasonable that all members must pay a proportionate share of the ongoing operational costs of the company, calculated by reference to their volume throughput in the system. The clearing companies are not for profit, guarantee companies which are run on a break-even basis. Therefore, the notion that institutions cannot gain access to payment systems in Ireland without the support or sponsorship of an existing institution is patently wrong.
Neither the IPCC nor the IRECC has received, since they were established in 1997, any applications for full membership but institutions have become associate members through agency arrangements. Such arrangements are obtainable on a competitive tender basis from full members in an entirely confidential manner. The companies have not been required to calculate what the costs attaching to entry are but if they receive an application, the costing exercise will be undertaken immediately. Costs, volumes and infrastructure do not remain static and the impacts of a new bank joining will vary depending on the time of entry and the bank involved. Thus, this cannot be carried out as an academic exercise in isolation.
Mindful of competition law considerations, own bank costs of running a bank's clearing operations are confidential to that bank and thus could not be shared with the other banks. This also explains why it is difficult to evaluate the actual costs of participation in the retail clearings in Ireland. Although no bank has ever been refused entry to membership, a right of appeal process is enshrined in the companies' rules for membership. The CBFSAI, as statutory regulator and overseer of payment systems, provides that function and can request the board of a clearing company to reconsider its decision on a membership application.
It should be noted that there is no shared, centralised infrastructure in any of the payment systems in Ireland. Each bank has over time built up its own infrastructure. These individual infrastructures are interlinked to provide inter-operability. There is no centralised clearing house in Ireland to which new banks can join by plugging in and playing. Thus the suggestion made at 11 July meeting of the committee that a profitable clearing house exists in Ireland is not factually correct. Another widely held myth is that because Ireland does not have a central clearing house our payments clearing must be inefficient. That is not proven. For example, Finland does not have an ACH, a central automated clearing house. Interestingly, Finland is generally reckoned to be the most advanced and most efficient country in terms of payments by the European Central Bank. The failure of the BACS system in the UK in 1997 shows the dangers of a centralised clearing house to which banking regulators worldwide have drawn attention since 11 September.
The governing rules of the clearing companies provide for the concept of proportionate voting according to volume throughput in the clearing. This structure was approved by the Central Bank and to date has not given rise to any particular problems. Moreover, it is consistent with governance in payment systems in the UK and worldwide. The fact that the retail clearing companies are constituted by guarantee, not share capital, is an academic point in the context of funding the costs of any payment system. For example, although IRIS, the real-time gross settlement company, is constituted by share capital, the number of shares allocated to members is based on volumes.
I want to say a few words about comparisons with the UK, which have received much media comment and innuendo. Despite what has been said both before this committee and in the media, the rules for membership of payment systems in Ireland broadly mirror those in the UK. There are some small differences. UK payment systems have recently dispensed with their minimum volume threshold but, on the other hand, they have introduced an additional criterion which we have had in Ireland for some time, although we have expressed it differently, that is, a new member joining a payment system in the UK must be confirmed as an acceptable risk to all existing members of the system. The retail clearing systems in the UK require the members to put up pre-funded collateral and loss sharing arrangements are in place in the event of the collapse or default of a bank. No comparative collateral requirements exist as yet in Ireland and consequently the significant costs associated with collateralisation are avoided.
I cannot stress enough the critical importance attaching to the need to protect the overall integrity of payment systems, and retail payment systems in particular. Unlike IRIS where payments are settled in real time at the Central Bank, both IRECC and IPCC are net end-of-day settlement systems. A significant industry exposure between banks thus exists intra-day, so knowing counter parties and having confidence in them is the key to the operation of payment systems in Ireland and their ongoing soundness. Default of a member of a payment system would be a serious issue for not only the other members but also for the economy as a whole. It could impact, for example, on the payment of salaries and pensions and Government welfare benefits.
I am qualified to talk on the UK situation as I was previously a member of the senior management team of both APACS, the equivalent body to IPSO in the UK, and subsequently at BACS, the UK's automated clearing house. IPSO has close ongoing liaison with our UK counterparts, as we do with payment associations throughout the world.
Applicant institutions to any of the payment schemes in the UK are required to pay entry costs and impact costs to the incumbent members. This is a feature common to payment systems' access criteria in many countries. International banks which are members of systems in several countries recognise the need to pay such costs and accept that there is no such thing as free rider status. It seems inconceivable that a bank which is a member of a payment system in one country where systems levy entry/impact or alignment costs should seek to question the validity of such costs or argue that such costs are anti-competitive or restrictive in another country. That is applying double standards.
Arguments were also made before this committee that payment systems in this country are operated by private companies and that that is not in the national interest. This is not unique. Privately owned companies operate payments systems in the majority of countries. Central Banks play a key role in the provision of payment services in certain countries, such as Germany. Moreover, Central Banks perform the function of settlement for payment systems in all advanced countries. In some countries, such as the US, privately owned systems exist side by side with Central Bank owned systems. Rather than ownership being the key concern from a public policy or regulatory perspective, of more importance should be the ongoing integrity, reliability, robustness, security and soundness of systems. The main requirement of the end user is a cost effective, secure money transmission system. His or her concern is not who owns the system but the certainty that a payment will be made. The system must work and work well, seamlessly to the consumer daily.
Any suggestion that industry ownership of systems is a barrier to entry is, with respect, misplaced. This was again, for example, not an issue for the Competition Authority nor for the Minister for Finance in 1995. It should be recognised that paper clearing systems are highly expensive to operate for banks. The cost of infrastructure and the processes involved represent a huge cost to the industry. IPSO has been seeking for some time to convince key stakeholders, including the Government, of the crucial need to transfer their payments to electronic means. At the same time we are mindful of competition law implications. The benefits of migrating away from paper to electronics will accrue to the wider economy, as evidenced in the recent Accenture Report, commissioned by the Information Society Commission. Cheques are declining in usage, but not at the rate necessary to improve our national competitiveness and bring us into line with our European counterparts.
It is also somewhat surprising in my experience that any bank would wish to become a full member of the paper clearing system when unit costs are rising rapidly in a declining payment system. The UK banks have almost entirely exited the cheque processing industry by outsourcing this expensive task to two outsourcing companies, IPSL and EDS. There have been no entrants to the UK cheque clearing for some years, which is structured in the same way as IPCC. If any barrier to entry exists in payment systems, this could be said to be the costs of setting up the infrastructure necessary to engage in cheque clearing on a direct participation basis. That barrier is not, however, imposed by the industry.
When approaching participation in a payment system in any country an applicant institution is faced with a classic rent or buy decision. The bank can either become a full member in a system and invest in the infrastructure to allow the bank to meet its obligations and rules of the system or it can avail of agency arrangements by using the payment services of a full member. The latter route involves no or minimum investment in infrastructure and thus provides a more cost-effective solution to the provision of services to its customers by the small or marginal bank. Exactly the same services are provided through either the full or associate membership route and the ability of a bank to offer services, such as personal current accounts, to end user customers is not impaired by virtue of a bank availing of the agency arrangements of another bank. The international banks' use of BNP Paribas in both IPCC and IRECC is a manifestation of this fact.
Clearly, the two-tier membership structure, which also exists in the UK, is a way that actively facilitates non-indigenous banks entry into payment systems rather that acting as a barrier to entry, real or perceived. An independent report issued by Davy Stockbrokers in February 2003, which commented on the Competition Authority's study into the banking sector, seems to bear out this fact by stating on page 18: "The entry costs and conditions associated with gaining access to the money transmission system are not the kernel of the problem, as any bank can become a full clearing bank and set up its own infrastructure or, as seems more likely, agree a deal with one of the existing clearers". Full membership of a clearing system implies costs, responsibilities and obligations which should not be taken on by the faint hearted or by banks lacking payments expertise or by those seeking a free ride.
Turning to the role of the Central Bank, to reiterate, the regulation of payment systems was put on a formal statutory basis by the Oireachtas in 1997. It was this House which provided for the Central Bank to be the regulator, and under more recent legislation the CBFSAI. The Central Bank has regulatory responsibility to ensure that payment systems are effective, efficient and open. The Central Bank also has regulatory responsibilities to ensure fair access to payment systems, such as cheque clearing, by non-clearing banks. As independent regulator of payment systems, the Central Bank can impose terms and conditions on payment systems' operators limiting the conditions of access and any entry fees. If any applicant has any concerns regarding either the conditions of access or the costs of entry, they are free to take the matter up with the Central Bank for its consideration.
It should be noted that any member of a payment system who has concerns regarding terms of membership or the operation of the system is free to take the matter up with the Central Bank as regulator for its consideration. In effect, therefore, this is a right of appeal. This should presumably be a comfort to smaller institutions which are concerned about the possibility of being outvoted.
The CBFSAI carries out its own investigations and reviews of payment systems issues, including undertaking on an ongoing basis its own independent risk assessments of the clearing companies. The CBFSAI is in frequent dialogue with IPSO and the individual clearing companies and seeks written reports on payment systems activities, including statistics, reports on projects, initiatives and developments. A statement made at the 11 July hearing of this committee suggested that the Central Bank has called for, or is carrying out, a review of payment systems in Ireland. The CBFSAI is currently engaged in a study but my understanding from talking to it is that the focus of its research in the area of retail payments is with a view to building up a comprehensive profile of retail payment instruments, that is, products and services currently available from banks in the Irish market. The CBFSAI wrote to 22 credit institutions in May 2002 requesting completion of a detailed questionnaire. I understand the CBFSAI is currently preparing an analytical report on its findings.
IPSO is not aware of any concerns or unhappiness on the Central Bank's part about the organisation and structure of the payments industry or about access to payment systems in Ireland.
Chairman and members of the committee, I agree with previous submissions that current payment systems in Ireland are efficiently run and regulated. I do not agree that the rules for membership or access to systems are rotten, as suggested by one banker who gave evidence before this committee on 11 July nor is it a strange club. Everything in any walk of life is open to improvement but I do not believe there is a case, nor do the facts support a case, for a fundamental reform of payment systems in Ireland. It is my assumption that, from a public policy perspective, there is general satisfaction with the regulatory regime for payment systems in Ireland given, for example, that this House saw fit to make practically no change under the Central Bank and Financial Services Authority of Ireland Act 2002 to the terms of the statutory code of regulation provided under the Central Bank Act 1997.
The payment systems being operated under the IPSO umbrella are well run and well supervised by an independent regulator. They have open, transparent and non-discriminatory terms of access. In summary, the system works, efficiencies are generated through competition at the front end of the banking sector and certainty of payment is the key driver in the eyes of the end user customer.
Looking to the future, the development of an integrated electronic payment infrastructure, accessible by all institutions and by all citizens, is IPSO's strategic vision and central to our five year strategic plan. Government leadership is key to allowing IPSO and its members take forward that plan. In addition, Government must demonstrate by example by becoming an intelligent user of electronic payment services itself. It is the largest issuer of cheques in the country and has the most to gain, therefore, from switching to electronics. Fiscal requirements, such as the abolition of stamp duties, must also be aligned with an electronic payments strategy.
IPSO is keen to commence the engagement process with all stakeholders to develop a strategic road map to deliver a national plan for payments. Ireland must play its full part in the single euro payment area, which demands efficiency reforms in the way we make payments. The commitment of this committee to our overarching objectives will be very welcome in that process. I would, for instance, welcome the continuing interest of the committee in the significant challenges facing payment systems and to ensure that the payments agenda becomes a more immediate focus of Government. This would be in the interest of all concerned, not least consumers. Perhaps as a practical step, the committee might propose the creation of a national payments forum comprising specialists from various sectors and key stakeholders in the payments business to promote innovation and collaboration in payments systems and thus bring about these essential efficiency reforms. IPSO would be happy to facilitate such a forum.
Chairman and members of the committee, I thank you for your attention.
